It is of paramount importance to every individual in a modern civilized community that banking credit should have the same solidity as coined money.
– Charles Connant, “Principles of Money and Banking,” 1905
In “The Return of the Great Depression,” I predicted that “the consensus scenario will gradually transform from Green Shoots into Jobless Recovery, which will remain the mainstream consensus until it begins to become apparent in the autumn of 2010 that even Jobless Recovery is too optimistic.”
It would appear I was somewhat too optimistic myself despite my frequent contentions that we are passing through the early stages of a large-scale economic contraction that will last more than a decade. It is only summer, and yet already the dread “double-dip” term is being regularly bandied about, while the last champion of neo-Keynesian economics, Paul Krugman, has begun to hedge his bets by complaining that the two previous stimulus packages were too small and talking about “the third depression.”
The reason Krugman and all the other mainstream economists have been unable to grasp the extent or the nature of the catastrophe facing the global economy is that they distinguish between money and credit. All of the economic models that rely on calculations of money supply and interest rates focus solely on money, and therefore they fail to take credit into account. But this is a huge mistake because not only does credit operate as money in a modern debt-based economy, most of what is properly considered money is actually credit!
There is not the space in a single column to explain the way in which the fractional-reserve banking system operates or to explain how conventional money is itself a special form of credit, but rest assured that significantly more money is created through the bank loans that give the system its name (the “fractional reserve” refers to the $1.03 trillion that the depository institutions are presently keeping on hand to back the $7,692,000,000,000 in deposits), than is printed by the Federal Reserve.
As everyone with a credit card knows, money and credit are exactly the same thing when considered from the spending perspective. Since mainstream economics statistics are based on the total amount being spent without distinguishing between spending money that does not have to be repaid and spending credit that does, it cannot possibly forecast what will happen when the amount of available credit begins to disappear. And this is already happening; whereas the fractional-reserve ratio was only 0.75 percent in 2008, it is now 13.4 percent. This increase in reserves, 16 times more than required by the Fed, represents a shrinking of the credit-money multiplier and therefore the amount of credit money available for spending.
According to the Federal Deposit Insurance Corporation, as of March 31, 2010, total bank loans have shrunk from $7.7 trillion to $7.5 trillion over the last year. And the net loan charge-off rate has increased from 1.93 percent to 2.84 percent. This is why the attempts of the Fed and other central banks to print and spend more money have gone for naught, because the supply of banking credit is shrinking faster than the supply of conventional money can grow. And because the Federal Reserve is responsible for both banking credit and conventional money, it is the past policies of the Federal Reserve that have created the present situation.
Unfortunately, rather than passing Rep. Ron Paul’s bill to audit the Fed to figure out exactly how dire the nation’s financial straits really are, the House and Senate elected to give more matches and gasoline to the very financial arsonists who have burned down the national economy. They wrongly presume that giving more power to the culpable party will allow it to fix its past mistakes. What will actually happen is that the Federal Reserve will use its extended powers to exacerbate the situation.
In accepting the strategy of federal intervention in the economy, the Obama administration is making the same costly mistake that the Hoover and Roosevelt administrations did. But the Obama administration has made an even bigger mistake, because whereas the two Great-Depression-era administrations created new organizations through which to exert central control over the economy, the present one is placing its hopes in a failed institution that is dependent upon the very failed economic theories and financial policies that created the current situation.